Consider a firm with constant marginal cost that behaves competitively. A horizontal merger lowers the firm's marginal cost and causes the firm to behave like a monopoly. How does the merger affect producer's surplus, consumers' surplus, and social gain? Explain.

Question

What will be an ideal response?

Answer 1

The merger will cause producer's surplus to rise. Prior to the merger, producer's surplus was zero. After the merger, the monopoly power allows the firm to charge a price in excess of its marginal cost, which allows the firm to earn positive producer's surplus. The monopoly power created by the merger will cause consumers' surplus to fall, unless the cost reduction is so large that the post-merger monopoly price is lower than the pre-merger competitive price. Social gain could either rise or fall as a result of the horizontal merger. For social gain to rise, the increase in producer's surplus must outweigh the loss in consumers' surplus.